What stops someone from abusing the Annual Gift Exclusion Amount?

Question

Let's assume this hypothetical.

My son is now 18 years old. Since he was 8, I've been setting aside the annual gift exclusion amount and placing it in a safe in my house. With snipers guarding said safe :)

4 People are involved.

My brother, my father, my father in law and myself. I gift each one of them the annual gift exclusion, in which they instantly turn around and gift that money to my son.

2010: 13,000 x 4 = 52,000

2011: 13,000 x 4 = 52,000

2012: 13,000 x 4 = 52,000

2013: 14,000 x 4 = 56,000

2014: 14,000 x 4 = 56,000

2015: 14,000 x 4 = 56,000

2016: 14,000 x 4 = 56,000

2017: 14,000 x 4 = 56,000

2018: 14,000 x 4 = 56,000

2019: 15,000 x 4 = 60,000

That amount would come out to: $552,000 in 10 years. On his 18th birthday, he went and purchased a $552,000 house.

Since none of the spouses are involved, this wouldn't be considered gift splitting, and no one would need to file a form 709 out. No one has to claim anything since I gifted them, and they gifted my son.

....Right?

Answer 1

Gifts are unconditional. Gifting someone money so he can gift it again on his name is not actually a gift.

1. If discovered it would be fraud since you are giving your relatives money not as a gift to them but as a means to get around tax laws. Your relatives could reject to be part of a fraudulent schema¹.

2. While the IRS will probably not know automatically of this:

   a. they could begin to investigate any of your relatives about some unrelated issue and find about those money movements. Your relative could find himself in a tight spot and offer to collaborate.

   b. they could begin to investigate your son and ask you about the source of that income; and when you tell them about your father, your brother and your father in law they will ask them about it.

   c. If using banks, those movements (someone getting paid $X only with no reasonable motive only to pay $X -or a significant part of it- to your son) could trigger some bank money laundering detection scheme; the IRS would be notified then.

   In any case the IRS will be most interested if any of such people lives in conditions which makes such a gift extravagant (i.e. your brother lives on the minimum salary yet he gifts his nephew the maximum available amount).

3. Any of those people can accept your gift and just plainly keep the money. After all, gifts are uncondicional. You cannot just go and sue them; not only it would expose you but contracts for breaking the law are unenforceable.

TL;DR It is tax fraud. You could get caught. No one here knows the probability of the IRS discovering it or getting enough evidence to prosecute it.

¹ And if they do not know that it is fraud and learn about it after they had commited it, they could be VERY angry at you for not warning them.

Answer 2

You've got a good answer from @SJuan76, it is tax fraud. Since the annual gift exclusion amount is per person, if you are married you can gift your child 2x the annual exclusion amount. If your child is married and you are married you can gift 4x the annual exclusion amount. So you can give quite a lot without gift tax obligation (4x if both are married) and still quite a bit without additional filing requirement (2x if they are married).

Also, you can simply gift more than the annual exclusion amount without owing gift tax by counting the excess against your lifetime exemption (currently $11M). The majority of people don't have enough wealth to exhaust the lifetime exemption, so there's no need for a scheme to get around the annual exclusion limit.

Answer 3

All steps of a process are considered in total for tax purposes.

Under the Step Transaction Doctrine, the beginning-to-end of the process is considered:

interrelated yet formally distinct steps in an integrated transaction may not be considered independently of the overall transaction. By thus linking together all interdependent steps with legal or business significance, rather than taking them in isolation, federal tax liability may be based on a realistic view of the entire transaction.

1. You can give $15,000 to your child without reporting it.
2. You can give $15,000 to your brother without reporting it.
3. Your brother can give $15,000 to your child without reporting it.

However, if 1, 2, and 3 all happen, the end result is still that you have given $30,000 to your child. If this is not reported, that would be illegal.

Relatedly, unless you are planning on your estate plus the sum of all your gifts being greater than $11,400,000 (as of 2019), or $22,800,000 if your spouse is considered, there will be no tax at all to begin with. If you do expect to surpass the $11,400,000/$22,800,000 mark, you are well advised to consult with an accountant and/or tax attorney to provide the most tax-efficient solutions.